Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Monday, 21 December 2015

There’s a phenomenally easy way to eradicate poverty in less developed countries. I deserve a Nobel Prize for thinking of this. I’ll take Pakistan and the UK as examples, and it goes like this.

The entire population of Pakistan moves to the UK. Obviously that couldn’t be done instantaneously, but over five or ten years it could be done. And the entire population of the UK moves to Pakistan.

Since immigrants are amazingly productive (it’s racist to suggest otherwise), the new arrivals in the UK would all have the wages and output per head that are normal for a developed country. Any idea that Pakistanis would bring with them the political corruption and the poor levels of education that currently exist in Pakistan is racist, xenophobic, fascist, Nazi, etc etc. So clearly all the factors that currently explain poverty in Pakistan (genetic and/or cultural) disappear overnight when those migrants arrive in the UK.

As for UK citizens moving to Pakistan, they’d obviously retain the characteristics that make the UK one of the better off countries in the World, so “New Pakistan” (situated to the north of India) would immediately become a fully developed country.

What could possibly be wrong with that idea? What’s wrong will be obvious to tabloid readers, as to whether intellectual leftie broadsheet readers will be able to see what’s wrong, that’s debatable. “Out of the mouths of babes…”, as they say.

Sunday, 20 December 2015

That’s in this article. Essentially the article criticises the concept of debt free money. He says for example “Money is always and everywhere else an IOU”, and IOUs are of course a form of debt.

Another couple of sentences of his along similar lines to the latter quote runs as follows: “Imagine a sovereign that issues “debt-free” coins. They look like normal coins, but when you take them back to the exchequer, your taxes are not paid. The exchequer does not recognize them as a debt—as a promise to redeem yourself in tax payment–but rather as a bit of base metal.”

That’s not a bad point. What Wray is saying is as follows. When the tax authorities demand $X from you, that’s obviously a debt owed by you to government. And it’s widely accepted that one debt can be cancelled out by an equal and opposite debt. So if you give the tax authorities $X worth of $100 bills, then those bills perform the function of an “equal and opposite debt”.

However, in other respects, state issued money is genuinely debt free. To illustrate, Bank of England £10 notes say something like “I, governor of the Bank of England, promise to pay the bearer on demand the sum of £10”. So it seems those notes REALLY ARE a debt owed by the BoE to the holders of £10 notes.

But of course if you turn up at the BoE and demand £10 worth of gold or anything else in return for your £10 note, you’ll be told to shove off. So in that sense, state issued money is NOT A DEBT.

In contrast, debt is very much part and parcel of COMMERCIAL BANK created money. To illustrate, when you get a loan from a bank (perhaps after depositing security / collateral), the bank sets up two equal and opposite debts. First there is a debt owed by the bank to you, commonly known as “money”. And the bank undertakes to transfer that debt to others when instructed by you to do so when you use your cheque book, debit card or whatever. The equal and opposite debt is the undertaking by you to repay that money to the bank at some point in the future.

And just to muddy the picture still further, there is another sense in which money created by commercial banks is NOT a form of debt. I set out the details here.

Conclusion.

The concepts “debt based” and “debt free” money are complicated. There is certainly SOMETHING in the claim that commercial bank issued money is debt based, and in the claim that central bank money is debt free. But there are lots of iffs and buts to be attached to those claims.

Friday, 18 December 2015

By way of celebrating the recent rise in interest rates in the US, let’s run thru the litany of false logic behind interest rate adjustments.

The first problem is that while adjusting demand is an important function of the state, there is no earthly reason to do that by JUST changing borrowing, lending and investment activity. That is, THERE ARE households and firms which DO NOT borrow or lend to any great extent, while there are obviously others which borrow or lend significant amounts. And interest rate changes will influence the behavior of the latter much more than the former. There is no good reason for that distinction.

That is, given inadequate demand, the solution is to raise demand for ALL PRODUCTS or at least for a wide variety of products. I.e. there is more no reason to confine the change in demand to those who borrow heavily, than there is to confined the change in demand to chewing gum, cars, education and lollipops.

The free market’s cure for recessions.

Indeed, that “increased demand for almost all products” is exactly what happens under the free market’s cure for recessions: wages fall, which raises the value of the monetary base and government debt in real terms, which increases the private sector’s assets in real terms, which encourages spending (as pointed out by Krugman). That phenomenon is sometimes called the “Pigou effect” though Krugman doesn’t actually mention Pigou in that article. Obviously the Pigou effect doesn't work too well in the real world, though to judge by the 1800s, the free market does actually cure recessions eventually.

Of course if the change in demand IS NARROWLY focused (as under interest rate cuts), the extra demand will eventually trickle out to the rest of the economy, but that’s still no excuse for the initial narrow focus or distortion of the economy.

In short, when demand is adjusted, it should be adjusted by fiscal means or least to a significant extent by fiscal means because that normally involves stimulus for a broad selection of economic activities. That is, if for example personal taxes are cut, that increases spending by most households. Those in the UK who live just on the state pension would’nt be much affected by that, but their income can be increased by other fiscal measures: e.g. increasing the state pension.

Artificially high interest rates.

A second absurd aspect of interest rate adjustments is that the state has to artificially inflate interest rates if it’s going to go be able to subsequently CUT them.

To explain why, it is first necessary to clarify the distinction between two quite separate functions performed by the state: first, states (i.e. governments) often borrow so as to fund infrastructure and similar invetments, and second, governments borrow SIMPLY to rein in demand and/or raise interest rates.

To keep things simple, let’s assume the state funds infrastructure etc out of tax, or if it does fund them out of borrowing, then relevant bonds are kept separate from “as currency issuer” bonds. I.e. those infrastructure bonds could be issued on the same basis as a private sector firm might issue bonds, with bond holders standing to make a loss if the relevant projects go over-budget (as was the case with the French-English Channel tunnel).

So that’s infrastructure put on one side. Now let’s consider government as currency issuer and interest rates.

The amount of currency (i.e. base money) the state basically needs to issue is whatever amount keeps the economy at capacity. The state can of course issue an excessive amount, and deal with the resultant excess aggregate demand by borrowing some of that money back. But what’s the point of that? All it does is to artificially raise interest rates.

To repeat, in order to use interest rate adjustments to influence demand, governments have to issue an excessive amount of money and borrow some of it back at an artificially inflated rate of interest.

Inequalities.

Even more absurd is that process of issuing an excess amount of money and borrowing some of it back increases inequalities. That is, the less well off have to pay taxes to fund artificially high interest payments to the cash rich.

And alternative way to implement stimulus is for government to borrow and spend the money borrowed (and/or cut taxes). Plus it then has to buy back enough of those bonds to make sure the initial borrowing does not raise interest rates.

Apart from creating work for paper pushers and bankers in the world’s financial centres who take their cut at every turn, that process doesn’t make much sense, particularly given that the effect of borrwing is DEFLATIONARY. What’s the point of doing something that has a DEFLATIONARY element when the object of the exercise is the opposite, namely stimulus? That makes as much sense as throwing dirt over your living room wall before re-decorating it.

In short, why not do what Keynes suggested in the early 1930s, namely just have the state print money when stimulus is needed and spend it, and/or cut taxes. That comes to nearly the same thing as the Pigou effect.

Lags.

Interest rate adjustments might make sense if they worked more QUICKLY that fiscal policy, but all the evidence is that there is not much difference “lag-wise”.

Moreover, there is evidence that interest rate adjustments are not all that effective. As Jamie Galbriath put it, “Firms invest when they can make money, not when interest rates are low”.

And what do you know? The above policy of having government simply create new money and spend it in a recession is what’s advocated by a number of those who back full reserve banking. See here. And that in turn comes to much the same thing as the Pigou effect.

Controlling inflation.

Of course there needs to be tight control of the amount of new money created under the system advocated here. But that’s easily done by having some sort of committee of economists make that decision, like the EXISTING central bank committees that determine interest rate adjustments, QE and so on. Indeed, under the existing system and under the system proposed here, the job of that committee is the same: to determine the amount of stimulus needed.

And finally the above is not to suggest that adjusting interest rates is a tool that should NEVER be used. In an emergency obviously it’s a useful tool. But normally interest rate adjustments don’t make sense.

Thursday, 17 December 2015

In today’s Financial Times he has penned an article in favour of the UK staying in the EU. His first point is that the UK “.. has access to the single market..”.

Er – yes – and if the UK left the EU it would still have access to the “single market”, just like the UK has access to the US market, and all without being in any sort of political union with the US.

Why it’s necessary to make the latter blitheringly obvious point is a mystery.

Soros’s next point is that the recent Paris meeting on global warming illustrated the importance of countries working together on various issues, which somehow proves the need for the UK to stay in the EU. So if the UK was outside the EU, would it be particularly difficult for UK politicians to travel to Paris or any other European capital and take part in international meetings? I mean does the UK leaving the EU mean some sort of Berlin wall is erected in the middle of the English Channel, or what?

Soros’s third point is that Russia has territorial ambitions and the rest of Europe needs to stick together to counter that threat. Well there is an organisation called NATO which Soros evidently hasn’t heard of. And as a result of Poland and other East European countries joining NATO and/or the EU over the last 20 years, the NATO/Russia border is now several hundred miles nearer Moscow than it used to be.

Tuesday, 15 December 2015

Bit of an odd question isn't it? I mean there’s no reason to “fiscally consolidate” (i.e. cut the deficit / run a surplus and pay back government debt) unless the private sector is in exceptionally buoyant mood. Put another way, there is no good reason for the state to implement deflationary measures unless that’s needed to thwart inflation.

In short, the state SHOULD ensure as far as possible that demand stays constant and as high as possible. Or as Keynes put it, “Look after unemployment, and the budget will look after itself”. And assuming it does that, then there’s no reason for households to cut back. So what’s all that stuff in the BoE paper about households cutting back their spending?

Put another way, the only circumstances in which any sane government would go for fiscal consolidation in a big way are circumstances in which that fiscal consolidation would have NO EFFECT on household spending.

At any rate, I was lucky enough to overhear one of the BoE interviewers asking a household (in Bradford) about fiscal consolidation. It went something like this.

Knock at front door. Wife opens door.

Wife, “Hello luv”.

Bank of England interviewer, “Good morning madam. I’d like to ask you about fiscal consolidation.”

Wife, “Yer what pet”.

Interviewer, “Fiscal consolidation”.

Wife to husband who is in kitchen, “Hey Wilf, there’s somebody at t’ front door wants to know about fiscal consolidation”

Simon Wren-Lewis (Oxford economics prof) argues in The Independent that for the first decade or so of the Euro, Germany hammered down costs to an excessive extent and became too competitive. In particular he argues that Germany kept its unit labor costs too low.

Not sure about that.

The target that EZ countries are supposed to aim for is an INFLATION rate of just below 2%. And for the first decade of the Euro, Germany seems to have hit the target near enough, at least according to this source.
Incidentally Bill Mitchell also takes Wren-Lewis to task in a 3,500 word article today. But my 80 or so word criticism above is, needless to say, much more succinct and better value for money..:-)

Monday, 14 December 2015

This Financial Times article repeats the myth that bank capital is expensive. As the author puts it, “New regulations mean all banks must hold more equity, and that means they have to earn higher profits to keep return on equity at the levels investors demand.”

Seems it’s necessary to keep pointing out the fallacy in the latter point, so here goes.

Shareholders only demand a higher return than debt holders (i.e. bondholders and depositors) because shareholders get a hair cut FIRST when problems arise. I.e. it’s only AFTER shareholders have been wiped out that bondholders have a problem.

Ergo if the bank’s capital ratio is say doubled, then the extent of that “first hair cut” problem per share is HALVED. Ergo the return shareholders will demand for undertaking risk is halved. Ergo if the capital ratio is doubled, there shouldn’t be any effect of the total cost of funding the bank.

I get the distinct impression from the above quoted sentence that the author (Laura Noonan) doesn’t get that point, because she talks about “keeping the return on equity at” a particular level.

To illustrate the point another way, suppose there are two banks which are identical except that one is funded entirely or almost entirely by debt, and the other is funded entirely or almost entirely by equity.

The return demanded by both types of bank funder will be the same in that they’re both parting with savings rather than spending those savings. They will also demand a return in respect of risk.

But the risk of the bank going under is the same in both cases given that the riskiness of the banks’ assets is the same in both cases. Thus the chance of shareholders and debt holders being wiped out or losing X% of their money is the same in each case.

So shareholders and bondholders will demand the same return for parting with savings, plus they’ll demand the same for accepting risk.

The only possible escape from the above argument is that bondholders UNDERESTIMATE risk. That is the more naïve bond holders may be under the impression that £X of freshly issued bonds means the bondholder is guaranteed to get £X back when the bonds mature.

That however is not a strong argument for funding banks via debt because it involves taking advantage of peoples’ ignorance or naivity.

As distinct from the latter “naïve” reason for thinking bondholders will get their money back, there is a more sophisticated reason, namely the calculation that governments will not in practice let bondholders be ruined come a bank crisis. That calculation paid off hansomely in the recent crisis. That is, large bondholders are often personal friends of politicians and regulators. And one doesn’t want to ruin people one regularly meets at cocktail parties does one?

The morality of that reason for bonds being a cheap way of funding banks does not stand inspection, of course.

And finally, Google is funded 90% by equity. And as we all know, Google is a total failure. A complete basket case…:-)

Incidentally, I got that information about Google from avideo by Anat Admati.

Saturday, 12 December 2015

Friday, 11 December 2015

John Redwood is often said to one of the Tory Party’s intellectuals. Normally I agree with much of what he has to say. But in the second paragraph of this article he says in reference to helicopter money:

“By this they mean the Central Bank creates new electronic money in an account (the modern version of printing notes or clipping coins) and gives it to people. The idea is they would then go out and spend. The sages think that if the economy is working below full capacity then the extra money spent will be more demand, and will bring more of the unused raw materials and labour into use. Clearly the conditions would have to be very unusual. Normally if a Central Bank prints more and gives it away or spends the cash it leads to more inflation.”

Perhaps John Redwood can then explain to us why we’ve had an enormous increase in government / central bank created money over the last two or three years thanks to QE (both in the UK, US and elsewhere), yet inflation is nowhere in sight!!!!

You might argue that QE has not put money in to the hands of the “people” referred to by Redwood, but rather into the hands of the government bond holders who were bought out thanks to QE. Hence (given that the tendency of the wealthy to increase their spending when their stock of cash rises is more muted than in the case of the less well off) that would explain the relatively muted rise in spending and demand and hence inflation. Unfortunately that argument is weak and for the following reasons.

What happened in the recent “QE years” was that governments boosted fiscal stimulus (i.e borrowed more than usual and gave bonds to those it borrowed from). That will have transferred money from the rich to the less well off. The state (i.e. the government / central bank machine) then printed money and bought back those bonds. Net result: cash in the hands of both the rich and poor will have risen, which comes to the same thing as helicopter drops.

Unusual conditions.

Moreover, what’s all that nonsense in the above quote from Redwood about conditions having to be “very unusual” for increased spending not to cause inflation? The only condition needed is that the economy has significant spare capacity, or put another way that unemployment is above NAIRU: which has been the situation over the last seven years or so.

If a firm gets increased orders for its wares and it advertises for more staff, and suitable applicants are two a penny, then wages in the relevant professions / skills / jobs concerned will not be pushed upwards. In contrast, if there are skill shortages in relevant jobs, then wages WILL TEND to be pushed up. Inflation ensues.

Why I need to spell out this elementary stuff to a supposed intellectual is a mystery.

Are heli-drops desirable?

Having said that, I’m not actually advocating heli-drops (i.e. some sort of system via which every household gets the same amount of cash, or gets an amount inversely related to their income, or whatever). Reason is that heli-drops can be effected via the existing public expenditure system. That is, if you want to feed money into household pockets, why not just cut direct taxes, raise the state pension or something like that? Why set up an entirely new system, staffed by ten thousand bureaucrats to do more or less the same thing?

Thursday, 10 December 2015

I’m thrilled to learn from Ann Pettifor’s letter in the Financial Times today that “investment is not constrained by savings”. So the UK can invest £30bn in the proposed HS2 rail project, and no one needs to save in the form of spending less on beer, home improvements, cars etc to pay for it? This is wondrous news. Instant wealth appears from nowhere.

The relevant paragraph in her letter reads “As Keynes explained and understood, in an economy based on credit, investment is not constrained by savings. Many of those who lay claim to his theories still do not accept this basic principle of a credit-based economy — applied in the UK since the founding of the Bank of England in 1694.”

I’d like to be the first to propose Ms Pettifor is awarded a Nobel Prize for this amazing insight.

Wednesday, 9 December 2015

Working out the exact size of the subsidy or gift that taxpayers were forced to make to banksters is not easy. The following is back of the envelope estimate.

It seems from this source that the total amount loaned by the Fed to banks was $16trillion and the loans were at a zero or near zero rate of interest.

Now what would have been a realistic or appropriate rate of interest? Well Walter Bagehot’s famous answer to that was a “penalty” rate of interest, and in exchange for first class collateral.

One of the reasons for that penalty rate is that a borrower who suddenly finds their cash flow calculations are nonsense, is incompetent. Commercial banks themselves charge penalty rates to borrowers who suddenly claim they need emergency funding, and quite right.

As to exactly what that penalty rate should be, Warren Buffet loaned $5bn to Goldman Sachs at the height of the crisis at 10%. So presumably 10% is a fair “penalty rate”.

So roughly speaking, those Fed loans to banks were at zero percent, when in fact they should have been at 10%.

As to the duration of those loans, I don’t have exact figures, but to keep things simple, let’s say one year. On that basis, banks were subsidised to the extent of $1.6trillion. Or at least they were subsidised to the extent of $1.6trillion PER YEAR for however long the loans lasted.

The money came from thin air?

Several members of the revolving door brigade, with a view to claiming they weren’t subsidised at all, have claimed the Fed created the relevant money out of thin air (which it did), and hence that the whole operation didn’t cost taxpayers anything.

That claim is blatantly dishonest. Reason is that there was an alternative to rescuing banks: the Fed, or more generally “the state” (i.e. central bank and government) could have dealt with the deflationary or recession inducing effects of bank failures by simply dishing out billions to the country’s taxpayers, and citizens generally. And/or the state could have implemented a large rise in public spending (something a left of centre government might have chosen to do).

Now you might claim that largesse towards taxpayer / citizens would have been a subsidy of taxpayers just as much as lending $16trillion to banks at a near zero rate of interest was a subsidy. Well the answer to that is that it’s widely accepted that it is the state’s job to maintain demand at a level that keeps the economy at capacity or “full employment”, whether there’s a bank crisis or not.

Central banks and Treasuries do that ALL THE TIME: i.e. they cut interest rates when appropriate, adjust the size of the deficit and so on. And that activity is not normally regarded as subsidy, and quite right.

Moreover, dishing out money created from thin air to taxpayers during a recession simply immitates the free market’s own cure for recessions (which in practice doesn’t work very well). That is, in a totally free and perfectly functioning market, and given a recession, prices and wages would drop, which in turn would increase the value of the monetary base, which in turn increases the paper assets of the private sector, which in turn induces the private sector to spend more. And that cures the recession. That’s known as the “Pigou effect”.

Of course in the real world, the Pigou effect doesn’t work very quickly because as Keynes famously put it, “wages are sticky downwards”. That is, if you try to cut wages, you often get riots.

In short, if the state dishes out money to taxpayers during a recession (e.g. by cutting taxes), all the state is doing is to IMITATE or bolster the free market’s cure for recessions.

And a subsidy is a payment which does not take place under free market conditions. Thus, in a sense, having the state print and dish out money to taxpayers or citizens in general is not a subsidy.

In contrast, there is absolutely no way that having the state dish out trillions to a very small and select group of firms, banks or any other group, is not a subsidy.

__________

P.S. (11th Dec). David Andolfatto argues here that central banks should not charge penalty rates. In the comments, I stick to my view that the rate should be “penalty”.

Graeber should be congratulated for helping explain how the bank and monetary system really works, which is significantly different from how the proverbial man in the street understands it, and indeed how some economics text books explain it. However the following sentence of his in The Guardian is not correct. (The same error is made incidentally by others)

“What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow.”

The flaw in that argument is that the total amount of debt VASTLY exceeds the amount of money needed to make the economy work.

To illustrate, in the UK, SME trade debts alone amount to three times GDP, never mind mortgages and debts between large firms, etc. (That probably doubles the "three times" figure).

In contrast, the amount of money needed by the average household is little more than what's needed to tide them over from one monthly pay day to the next. That's roughly one twelfth GDP. But trebble that if you like and make it a quarter of GDP. That quarter of GDP figure is a minute fraction of the above three or six times GDP figure.

That point can be illustrated by reference to King Henry I and tally sticks, which are a form of money. Henry (who came to the throne in 1100) introduced tally sticks to England in a big way (though tally sticks were being used in some sort of fashion throughout Europe long before that).

You could argue that the amount of tally stick money was limited during Henry’s reign by the amount of wood available from which to make those tally sticks. However, that’s not a brilliant argument given that the amount of wood available for tally stick production was probably a good million times the amount actually needed.

Monday, 7 December 2015

James Tobin wrote a work entitled “The Case for Preserving Regulatory Distinctions”. The following is a longish extract.

I believe, therefore, that the monetary and depository system should be restructured to reduce the reliance now placed on deposit insurance to protect the monetary payments system. I have two proposals. One is to provide a kind of deposit money so safe that it does not have to be insured. The second is to make in advance a sharp distinction between insured and uninsured liabilities, and to stick to it. This involves separating "commercial banks," which accept insured deposits, from "investment banks," which do not.

To diminish the reliance of the payments system on deposit insurance, I have proposed making available to the public what I call ' 'deposited currency. " Currency-today virtually exclusively Federal Reserve notes-and coin are the basic money and legal tender of the United States. They are generally acceptable in transactions without question. But they have obvious inconveniences-insecurity against loss or theft, indivisibilties of denomination-that limit their use except in small transactions (or in illegal or tax-evading transactions.) These disadvantages, along with zero nominal interest, lead to the substitution of bank deposits for currency. But deposits suffer from their own insecurity, unless guaranteed by the government; and the guarantees of deposit insurance are subject to the abuses discussed above.

I think the government should make available to the public a medium with the convenience of deposits and the safety of currency, essentially currency on deposit, transferable in any amount by check or other order. This could be done in one or more or the following ways:

(a) The Federal Reserve banks themselves could offer such deposits, a species of "Federal Funds." Presumably they would establish conveniently located agencies in private banks or post offices. The Federal Reserve banks would pay for the services of the agents. Potential agents could bid for the contracts. Transactions between holders of deposited currency accounts, or between them and, directly or indirectly, other Federal Funds accounts would be cleared through the Federal Reserve. Wire transfers, as well as checks, would be possible. Giro-type payment orders to other accounts in the system could be made. Overdrafts would not be allowed. Computer capabilities should soon make it possible to withdraw conventional currency at any office or agency, and even to order payments to third parties by card or telephone. Interest at a rate sufficiently below the rates on Treasury securities to cover costs could be paid, and some costs could be charged to accountholders.

(b) Banks and other depository institutions could offer the same type of account, or indeed be required to do so. The deposited funds would be segregated from the other liabilities of the institution, and invested entirely in eligible assets dedicated solely to those liabilities. These would be Federal Funds or Treasury obligations of no more than three months maturity. As in case (a), interest might be paid on Federal Funds in such segregated portfolios.

Sunday, 6 December 2015

If you lend direct to a corporation, i.e. buy its bonds, there is no taxpayer support for you if it goes wrong, and quite right. In contrast, if you lend to a bank (i.e. make a deposit at a bank) and the bank lends to the same corporation, government guarantees you’ll get your money back.

So if you lend DIRECTLY to a corporation, you’re on your own. But if you lend via a bank, the taxpayer rescues you if it all goes wrong. That is an obvious anomaly. So what’s the explanation?

Well the authorities’ motive for maintaining that anomaly is the idea that “money should be used”. I.e. the idea is that money deposited at banks should as far as possible be put to good use. (See for example the Vickers report, sections 3.20-24) That is, if deposits were not loaned on, that money would stand idle, plus total amounts loaned would decline, which would first, cut demand, and second raise interest rates.

As to the “cut demand” point, that is easily dealt with by raising demand (surprise surprise). That is, for example, the state can simply create new money and spend it, and/or cut taxes, with a view to keeping demand at the full employment level, or NAIRU if you like acronyms.

As to the interest rate rise point, the crucial question there is whether the free market rate of interest is attained under the above “anomalous” regime, or under a regime where money which is supposed to be safe is not loaned on. And the answer is that the free market rate of interest (i.e. the GDP maximising rate) is achieved under a “not loaned on” regime.

Reason is that the only way of making loaned on money is safe is to have the taxpayer stand behind that arrangement, i.e. subsidise the arrangement. And subsidies, unless they are for good social reasons, result in GDP not being maximised.

And finally you may have noticed that the above “idle money should be used” argument is just one of dozens of examples of one of the most common mistakes in economics, namely applying microeconomic rules at the macroeconomic level. That is, it makes sense for a microeconomic entity like a firm or household to put its stock of money to good use as far as possible. But from the point of view of the economy as a whole, that argument doesn’t hold. That is, if a proportion of the population decide to hoard large quantities of money, that matters not one iota: the deflationary effect of that can easily be dealt with by having the state simply create and spend whatever amount of money is needed to keep the economy at capacity.

Friday, 4 December 2015

Warren Mosler says in this Huffington article, “The hard lesson of banking history is that the liability side of banking is not the place for market discipline.” Normally I agree with Warren, but no this occasion.

First he doesn’t tell us what the “hard lessons” are or whereabouts in history those lessons are.

Second, regulating the asset side is complicated: witness Warren’s own list of ideas for regulating the asset side in the above Huffington article. But if you want REAL complexity, look at Dodd-Frank: it consists of about 10,000 pages and counting.

In contrast, regulating the liability side is simple. One popular form of “liability side” regulation is raising bank capital ratios. The rule “Banks shall have a capital ratio of 25%” (as advocated by Anat Admati and Martin Wolf) is simple enough.

And taking that further, the basic rules of full reserve banking (which involves a 100% capital ratio) can be written on the back of an envelope. They are:

1. Entities accepting deposits which are supposed to be totally safe can only lodge that money at the central bank (and/or perhaps invest in government debt).

2. Those funding money lenders must accept the risk involved in doing that (rather than having the taxpayer carry the risk).

3. Money lenders must offer a variety of types of loan that “lender funders” can fund. I.e. savers must have the choice of putting their money into safe mortgages, NINJA mortgages, small firms, etc.

And that’s it.

A third problem with regulating the asset side is that the obvious way to make banks / lenders safer is to make the nature of the loans they make safer, e.g. insist that mortgagors have some minimum equity stake in their houses.

But doing that rules out risky loans, and some risky loans turn out to be winners: they’re the basis for starting up businesses which subsequently prosper.

So…. why not allow lenders make any loans they want, as long as those funding those loans carry any loss (rather than taxpayers carrying the loss), and as long as lenders are open and honest with funders as to what’s involved?

And what do you know? The above sort of “regulate the liability” side is what’s involved in full reserve banking, at least as per Lawrence Kotlikoff and Positive Money.

Thursday, 3 December 2015

Krugman considers the free market’s cure for recessions, and points to the fact that in a recession, prices would fall, which would raise the real value of money, which in turn would increase the paper assets of the population, which in turn would encourage spending. That’s known as the Pigou effect (though Krugman doesn’t mention Pigou). As Krugman puts it:

“How is the self-correction of an economy to its long-run equilibrium supposed to work? In textbook analysis, the story is that falling prices raise the real money supply, pushing down interest rates, and hence restoring employment.”

Note that BASE MONEY is the all important form of money here because base money is a net asset as far as the private sector is concerned. In contrast, commercial bank created money nets to nothing because for every dollar or pound of such money, there is a dollar or pound of debt. Thus commercial bank created money is not a net asset as far as the private sector is concerned.

Krugman however doesn’t mention Say’s law, which is another mechanism that tends to bring full employment (though like the Pigou effect it doubtless doesn’t work all that well). Say’s law works even in a barter or non-money economy. I set out a full explanation here.

At least I take it the latter exposition of mine is how Say’s law works. Maybe I’ve thought up an entirely new mechanism that enables the free market to bring full employment, in which case I’d like a Nobel Prize please.

Tuesday, 1 December 2015

Summary. Conventional banks combine two activities, lending and accepting deposits. That combination is essentially fraudulent. The harmful effects of that fraud are remedied to some extent by deposit insurance and lender of last resort. However no public purpose is served by those forms of state assistance to money lenders any more than offering that form of assistance to non-bank corporations would serve public purpose or bring social benefits. Ergo those two activities, lending and accepting deposits, should be separated.

____________

Private banks have always liked to merge the above two activities, that is, have the same institutions (private banks) perform both functions. Reason is that that “merge” enables private banks to engage in “borrow short and lend long” (i.e. maturity transformation). And that’s profitable.

Unfortunately the above merge is risky. As Adam Levitin (professor of banking law) put it in the first sentence of the abstract of this paper: “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and re-lending of deposits.”

The irreconcilability or fraud consists of the fact that banks promise depositors they’ll get their money back at the same time as putting that money at risk by lending it on. That tactic is bound to fail at some point, and when it does depositors are fleeced big time, as happened in the 1930s. Or if government run deposit insurance is in place, which it wasn’t in the 1930s, then it’s still someone other than the miscreant bank who pays, which is nice for the miscreant bank and those funding it. A second form of protection offered by governments / central banks for the above merged system is lender of last resort (LLR).

So there are two possible bank systems. First, a system under which entities which accept deposits lend on those deposits. In view of the risks involved there, taxpayers have to stand behind private banks. Second, there is a system which solves the above problems by having the state only guarantee money lodged with the state. As to lending, that is funded by people who specifically choose to have their money loaned on, and who buy shares or similar stakes in money lenders, and those shares are of course not the same thing as deposits.

A “merge” system protected by deposit insurance and LLR might seem to make sense. In fact it’s a system riddled with flaws, as follows and numbered.

1. The system involves moral hazard: the temptation to take excess risk, keep profits when that works and send the bill to the insurer when it doesn’t. Indeed, it was precisely that that contributed to a significant extent to the crisis in 2007/8.

2. One common excuse for having the state insure money lenders and those who fund them (cited for example by the UK’s Vickers commission) is that doing so encourages loans and investment. Unfortunately exactly the same argument applies to every other industry and those funding them. That is, the latter “encourages investment” argument could equally well be applied to all stock exchange quoted shares and corporate bonds.

Of course there’s no harm in letting those who buy stakes in money lenders or any other industry insure themselves against loss, and a certain amount of that type of insurance takes place. However, to justify the state getting involved in that insurance, there must be some very clear social benefit or public purpose served.

3. The idea that governments or regulators are actually able to work out likely risks and charge an appropriate insurance premium is a joke in view of 2007 crisis.

4. Banks are bound to lobby politicians for an unrealistically low insurance premium.

5. When there are bankruptcies in any industry, it is positively HEALTHY for those who funded the industry to lose out. Bankruptcies tend to indicate the industry is too large, and that resources should be diverted to other activities. Thus far from any public purpose being served by deposit insurance, harm is actually done: that is, the effect is to recompense those who fund money lending, which encourages them to engage in more money lending, or “debt creation”.

I.e. when the FDIC reimburses depositors in a failed bank, depositors put the money in another bank. Failing to deal with malinvestments is a misallocation of resources: it reduces GDP.

It could of course be argued that if state sponsored deposit insurance does harm or reduces GDP, then the same applies to the private insurance (mentioned above) that is sometimes taken out for stakes in industries other than banking. That argument is not totally invalid: that is, possibly the latter form of insurance should be banned.

On the other hand, private insurance is not as “sure” as state sponsored insurance in that private insurers can go bust. I.e. private insurance is in a sense not insurance. Also it’s a generally accepted principle that people should be allowed to do whatever they want (e.g. insure their own legs) unless some very clear harm comes what they do.

So it’s debatable as to whether private insurance of investments like stock exchange quoted shares should be allowed or not.

6. Where money lenders are funded by shares, the entire system is more robust. As the former governor of the Bank of England, Mervyn King put it: “..we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve, and when they suffer sharp falls, economic policy can respond. But when the banking system failed in September 2008, not even massive injections of both liquidity and capital by the state could prevent a devastating collapse of confidence and output around the world.”

In short, banks funded by equity are more resilient than where they are funded by debt (e.g. deposits).

7. Bank regulators the world over have expressed approval of the principle that banks should be treated like any other industry: i.e. that ideally governments should openly declare that no form of assistance will be offered to banks in trouble. Of course what regulators and politicians say in private is very different. As John Kay put it, "With crass hypocrisy, political leaders have set their public faces against future bank rescues while their operatives have reassured markets that they do not mean what they say."

But assuming a government does openly and explicitly declare that there will be no assistance for failing money lenders, then the stakes in those lenders (deposits in particular) ipso facto become shares or bonds or something of the sort: so those stakeholders stand to lose money, whereas depositors are guaranteed not to lose out.

8. Another point which casts doubt on any idea that any public purpose is served by having the state insure those with stakes in money lenders (or any other industry) is the fact that there is a nonsense at the root of that type of insurance, as follows.

The only reason that those who fund money lenders (or any moderately risky industry) get a larger return than is obtainable from near risk free loans, is that more risk is involved. Now if the risk consists for example of a one in X chance of losing all your money in any one year, then the appropriate annual insurance premium would be 1/X of the sum insured. But that wipes out the profit derived from taking the extra risk (never mind the fact that the insurer will want some sort of profit on turnover and capital employed).
In short, insuring those who fund money lenders is as daft as insuring your own legs: to repeat, it probably doesn’t do any harm to let people take out daft forms of insurance, but there certainly isn't any public purpose or social benefit to be had from insuring those who fund money lenders or other industries.

9. In addition to deposit insurance, another form of assistance for private banks is LLR. The rate charged for LLR loans are supposed to be the “penalty” rates suggested by Walter Bagehot. In practice, and thanks to political pressures and bribes payed by bankers to politicians, those rates are nearer zero than “penalty”: a form of subsidy for banks.

10. Contrary to popular belief, Bagehot did not advocate LLR: in the final chapter of his book “Lombard Street” he simply said he thought LLR was so entrenched that it would be very difficult to remove.

11. It is often argued that if the PROPORTION of funding for money lenders that comes from shares is sufficiently high (i.e. if bank capital ratios are high enough), that solves the problem: that is, the chance of depositors losing out can be reduced to a vanishing small level. Thus there is no need for 100% of those who fund money lending to be exposed to risk, i.e. depositors can still to some extent fund money lending.

A problem with that argument is that if those depositors are in fact totally safe at say a 30% capital ratio, then they’d also be totally safe of the rules of the game were changed and their stakes in money lenders became say preference shares. And in that case, those shareholders would charge the same for funding the bank as those former depositors (because the charge made by funders is related to risk, and the risk in both cases is the same). Thus if bank capital ratios are raised to whatever level makes banks totally safe (say 30%), then the cost of funding banks will not rise any further if the ratio is raised to 100%.

Arguments against separation.

The main argument put against separating lending from deposit accepting (put for example by the UK’s Independent Commission on Banking) is that the result would be large amounts of money not being used: effectively, if you like, money sitting in metaphorical safe deposit boxes. The result, allegedly, would be a fall in demand and rise in unemployment.

The answer to that is that the deflationary effect of the separation can easily be countered by standard stimulatory measures, e.g. simply having the state print money and spend it (and/or cut taxes). Thus there is no reason for separation to increase unemployment.

Interest rates.

Another poor argument put against separation is that it would raise interest rates which allegedly would reduce investment and cut economic growth.

The answer to that is that as is widely accepted in economics, GDP is maximised where there is an absence of subsidies, except where there is a clear social case for a subsidy, as is doubtless the case with for example kid’s education. Or in more general terms, there is a case for subsidies and taxes where those subsidies put right an instance of market failure. (Taxes are imposed for example on alcohol because it is thought, rightly no doubt, that social harm derives from excess alcohol consumption.)

However, the onus is on those advocating subsidies and taxes to prove the existence of social benefits, market failure and so on. To repeat, the general and widely accepted rule is that GDP is maximised where market prices prevail, i.e. where there is an absence of subsidies or taxes.

In short the free market rate of interest is probably somewhat higher than the currently prevailing rate, thus moving to that higher rate ought to increase GDP, not reduce it, as claimed by the ICB and others.

And now – roll of drums – there’s “Climate QE for Paree”. That’s a cute name: guaranteed to fool most people.

The first important point to note is that printing money and increasing public spending was first advocated (far as I know) by Keynes in the early 1930s. It would be nice if Murphy gave credit where credit is due and gave himself correspondingly less credit.

As for the idea that we should spend more on infrastructure and/or climate change related stuff, I’m all for that. I’d like to see the price of petrol and diesel doubled tomorrow.

However, the idea that we should print money and spend that on infrastructure and/or global warming reduction confuses two issues as follows.

1. “Print and spend” is a method of imparting stimulus: desirable if the economy is at less than capacity, or put another way, if we don’t have full employment. Or put a third way, print and spend is desirable if unemployment is above NAIRU, but not otherwise.

Also, THERE ARE other ways of imparting stimulus, for example interest rate cuts, or (as proposed by market monetarists) buying up even more privately held assets, like stock exchange quoted shares. I don’t favour that market monetarist idea, but it’s a possibility, and if for some reason someone proves that method of imparting stimulus OTHER THAN print and spend are the best ones, then that’s the end of Peoples’ QE or Climate QE for Paree.

2. There’s the question as to how much we ought to spend on infrastructure and global warming reduction measures. Now there’s absolutely no reason to think the optimum amount to spend on those two will necessarily equal the optimum amount of “print and spend” that’s needed for stimulus purposes.

To put all that another way, it’s always possible that households and/or businesses go into a fit of irrational exuberance, and demand rises dramatically, in which case no stimulus would be needed at all – in QE form or any other form. What then happens to anti global warming expenditure?

To summarise, the logical procedure is to decide first how much to spend on infrastructure, global warming reduction, and then fund that out of tax, borrowing or “print and spend”: it really doesn’t matter which. Second, decide every month or so whether stimulus needs adjusting (something the BoE MPC already does).

Economists have a specific term (which I’ve forgotten) for funding particular forms of spending from particular forms of tax (e.g. funding the Navy just from income tax) and that idea is widely regarded by economists as nonsense. However that idea can sometimes be politically expedient, because it appeals to the untutored.

As for funding a type of spending (e.g. global warming reduction stuff) from print and spend, that’s even worse because in some years no stimulus is needed, in which case the source of funding for global warming reduction expenditure dries up altogether.

Sunday, 29 November 2015

When a widget maker fails, government doesn’t rescue of those who funded the widget maker, and quite right. Bankruptcy of widget makers indicates resources should probably be allocated to something else. But if a bank fails, government rescues those who funded the bank, i.e. relevant depositors. Bank failures probably indicate that too much borrowing and lending is taking place, i.e. that there’s too much debt. Deposit insurance thus helps ensure that that misallocation of resources continues.

Governments only have a motive for the above nonsense where two of the basic activities of banks can be combined, namely first lending, and second, accepting deposits which are supposed to be totally safe. Banks force governments to assist the first activity by forcing them to underwrite or insure the second.

The alternative and better option is to separate lending from deposit accepting. Under that arrangement, only deposits made at the central bank or put into government debt are insured by government. Plus under that “separation” arrangement lending is funded (as in any normal corporation) by shareholders, bondholders and the like (who can lose their money). There again, there is no need for state organised insurance.

Friday, 27 November 2015

This article entitled “Money Creation in the Modern Economy” (by sundry Bank of England authors) claims that loans are the source of commercial bank created money. Plenty of other literature makes that claim. As the opening sentence of the BoE article puts it, “This article explains how the majority of money in the modern economy is created by commercial banks making loans.” There is actually a glitch in that claim, as follows. (The BoE authors do say that there are reservations to be made to the “loans create money” idea, but not everyone pushing that idea makes the appropriate reservations.)

Obviously when a commercial bank grants a loan to some individual / borrower, and the relevant money is spent, that money ends up in the bank account of some other individual or individuals.

However, let’s assume, to keep things simple that the economy is at or near capacity / full employment. In that case, the inflationary effect of spending the new money must be matched by an equal amount of “spending abstinence”, i.e. saving by others, else excess inflation ensues. And if those others do not intend to use their new stock of money for a significant period, chances are they’ll put it into a term or savings account. At least if they’ve got any sense, that’s what they’ll do (with a view to earning more interest).

But the longer money is locked up for, the less money like it is. In fact when it comes to measuring the money supply, many countries draw the line between money and non-money at somewhere around the two month point. That is, if money in an account can be accessed within two months it is counted as money; if not, it isn’t.

Even if recipients of the new money DON’T put it into a term / savings account, i.e. assuming they put it into a current / checking account, that new money, again, cannot be spent, else inflation rears its ugly head. Thus that new money is effectively not money: it’s more in the nature of a long term loan to the relevant bank (which in turn makes possible a long term loan to the borrower we started with above).

Indeed banks recognise that a proportion of the money in current / checking accounts is in effect a form of long term saving: that’s one reason why banks know they’re safe lending that money on.

As to how recipients of new money are induced not to spend their new stock of money, the central bank might raise interest rates so as to induce more saving and forestall the inflation that would otherwise occur. But it’s possible those recipients increase their saving VOLUNTARILY.

In the above sort of scenario, commercial banks are simply engaged in their traditional activity, namely intermediating between borrowers and lenders.

Unemployment is above NAIRU.

In contrast to the above assumption that unemployment is above the level at which inflation gets serious (NAIRU), if unemployment is at NAIRU, i.e. the economy is not at capacity, then loans would indeed create money, i.e. the central bank would allow that to happen.

“Borrowers” owe banks, or vice-versa?

Another glitch in the “loans create money” idea is that when commercial banks create money, it is arguably not loans that do the creating, and for the following reason.

In an economy where people wanted a form of money (created by commercial banks), but didn’t want long term loans, people would simply deposit collateral at banks, have banks open accounts for them, and have banks credit money (created out of nothing) to those accounts.

But that process does not create any sort of long term debt. In fact banks, if anything, are indebted to bank customers, rather than the other way round. Reasons are thus.

Bank X would owe customer Y the collateral deposited (i.e. the bank must return the collateral at some stage). Second, there’s the artificial debt owed by the bank to the customer, that debt commonly being known as “money” (if you have $Z in your bank, the bank owes you $Z). And third, customer Y owes a debt to the bank in that Y undertakes to repay the newly created money to the bank at some state (maybe not till Y dies). So that’s two debts owed by the bank to the customer, and one debt owed by the customer to the bank!

Of course if a bank customer spends a significant amount of their new stock of money and simply leaves their account with a smaller balance than the initial balance, that constitutes a loan by the bank (and other depositors) to the customer in question. But on the above assumption, namely that people are simply after a form of money, not long term loans, than no customer would do that: the balance on each customer’s account would bob up and down around the original balance. E.g. the balance would tend to be ABOVE the original balance when the monthly pay cheque arrives, and BELOW the original balance three or four weeks later.

Conclusion.

Assuming an economy is at or near capacity, then loans do not result in money creation. Second, where money creation takes place, it’s not long term loans which create that money

Thursday, 26 November 2015

If bank regulators think that some level of bank capital, say 10%, means that the chance of a bank failing is vanishingly small, then it follows that the remaining 90% of bank funders (i.e. debt holders) run no risk, even if there’s no deposit insurance. But if those 90% were converted to shareholders, they’d also run no risk. Thus those shareholders wouldn’t charge any more for funding the bank than the latter debt holders. Ergo, once a bank has enough capital to make failure near impossible (e.g. the latter 10%) the capital ratio might as well be raised to 100%. Doing that won’t make any difference to the cost of funding the bank.

Wednesday, 25 November 2015

The opening sentence of this Financial Times article reads, “Mark Carney signalled that the Bank of England stands ready to increase capital requirements for banks temporarily as a way to curb excessive lending while interest rates stay low.”

First, what’s the point of a cut in interest rates (designed to encourage lending) and then negating that with higher capital requirements? Bit like driving a car with the accelerator and brake pedal permanently on the floor.

Second, it’s a popular myth that because bank shareholders demand a higher return than debt holders, that therefore increasing the capital ratio will increase the cost of funding the bank (or indeed any corporation). Shareholders demand a higher return because in the event of trouble, their hair gets cut first. However if the amount of equity is say doubled, then the risk PER SHARE his halved: thus there’s no effect on the total cost of funding the bank.

In fact taking that to the extreme, and comparing a bank funded just by equity as compared to one funded just by debt, in theory there’d be no difference in funding costs because the chance of funders losing X% of their stakes is exactly the same in both cases.

To illustrate, if it suddenly transpires that the assets of a bank are worth half their book value, then in the case of the equity funded bank, the shares will drop to half their initial value (on the simplifying assumption that the value of shares is determined just by the value of the underlying assets and not by the bank’s perceived prospects).

As to the debt funded bank, the bank will be wound up and the assets sold off. Debt holders will get back – wait for it – half their initial stake in the bank!

The pre-crisis house bubble.

Third, the pre-2007/8 crisis bubble took place DESPITE interest rates that were higher than today’s. Thus there is not much reason to suppose that low interest rates have much effect on bubbles.

Of course there’s an appealing logic in the idea that low rates cause bubbles. It runs something like, “Low rates induce people to borrow more, which pushes up house prices”.

Well that “borrow more when rates are low” phenomenon is entirely predictable and doesn’t constitute a bubble. A bubble is a feed back loop which can take off at any time. It runs something like this. House prices rise, which induces everyone to think they will rise further, which induces everyone to invest more in housing, which causes house prices to rise even further.

That can happen regardless of whether interest rates are high or low. To repeat, it actually did happen just prior to 2007.

Fourth, bank capital should be at a level that means there is a vanishingly small possibility of taxpayers having to rescue banks. Reason is that any such rescue constitutes a subsidy of banks.

Now if bank capital is actually at that level or above it, then raising bank capital further will not bring additional safety. On the other hand if bank capital is sufficiently low that THERE IS a possibility of banks being rescued, then bank capital should sod*ing well be raised anyway.

Fifth, if low rates do in fact promote bubbles, that’s just extra support for the idea pushed by Positive Money and others (me included) that interest rate adjustments are not a clever way of adjusting demand. Interest rate changes only influence the behavior of borrowers and lenders. A significant proportion of households do not have mortgages, nor do they lend significant amounts. Same goes for some employers. Why should the latter lot of households and employers be excluded when stimulus is the order of the day?

All in all, Carney’s idea is a litany of false logic. Though to be fair, he is trapped in a system in which false logic reigns supreme, so it’s not entirely his fault.

Tuesday, 24 November 2015

I dealt with one paper by Malcolm Sawyer and a co-author here recently. He actually published another paper at much the same time (June of this year) on the same topic. That topic was full reserve banking (FRB), and the title of the second paper is “The Scourge of Green Monetarism”. The latter is examined in the paragraphs below.

The word “green” is a reference to the fact that the UK’s Green Party has adopted the FRB ideas of Positive Money. Some points are common to both papers, so I’ll ignore those, as I have already dealt with them.

There is nothing wrong with Sawyer’s p.1, where among other things he introduces two terms: exogenous and endogenous money. The former is central bank created money or “base money” as it is sometimes called, while endogenous money is commercial bank created money.

Demand for and supply of money wouldn’t match?

At the top of p.2 Sawyer says that under FRB (i.e. an economy where only government or central bank created money is allowed) there’d be “..a mismatch between the amount of money which the central bank creates and the amount of money which the public is willing to hold.”

Well I have news: the above sort of mismatch arises under the existing system.

For example market monetarists like David Beckworth often claim (I think correctly) that the recent recession arose to a significant extent out an excess desire by the private sector to save money. But that in turn is just a repetition of Keynes’s “paradox of thrift” point.

So to the extent that the last seven years or so of excess unemployment are attributable to the above mismatch, FRB could hardly be worse than the EXISTING SYSTEM.

FRB resembles monetarism?

The second part of p.2 is the start of Sawyer’s claim that FRB closely resembles monetarism. As he puts it, “FRB shares many similarities with the ill-fated proposals of Friedman (1960) and others for the achievement of a specified growth rate of the stock of money.”

Well one problem with the latter claim is that if the state creates new money and spends it, and/or cuts taxes, there is an obvious monetary effect: the money supply rises. But there is also a fiscal effect: public spending rises and/or taxes are cut. Thus Sawyer’s claim that PM’s ideas amount to pure monetarism is very questionable.

Annual money supply increases.

A second problem is that a basic element of monetarism, at least a la Milton Friedman, was that it envisaged a small and fixed annual increase in the money supply. In contrast, PM advocates nothing of the sort. PM advocates that (much as under the existing system) stimulus should be varied from year to year dependent on the circumstances: e.g. whether there is excess inflation or whether the economy is in recession.

Mild monetarism is widely accepted.

Third, as distinct from monetarism a la Friedman, monetarism in a milder form is widely accepted in economics. That is, it’s widely accepted that the size of the monetary base has some sort of effect on inflation and output, as Robert Mugabe so ably demonstrated.

Why was QE implemented? Because the authorities thought that if the holders of government debt were given base money instead, there’d be some sort of stimulatory effect. Thus in that PM claims the amount of base money in private sector hands has some sort of stimulatory effect, that claim is completely uncontroversial.

FRBers ignore cost push inflation?

Page 6 of Sawyer’s paper then makes this bizarre claim:

“The FRB approach retains the monetarist perspective that the growth of the money supply (however defined) can control the rate of inflation, and that inflation is a money demand phenomenon which is to be controlled through manipulation of demand (and in the monetarist perspective through control of the money supply). Hence it ignores any role for cost-push inflation and imported inflation, and is willing to accept, if required, the reduction of employment in order to constrain inflation.”

The first of the latter two sentences just repeats the idea that there’s something wrong with the idea that the money supply has some sort of effect. To repeat, that idea is entirely uncontroversial.

As for the idea that because you think the money supply has some sort of effect that therefore you are ignoring “cost push” and “imported” inflation, that’s just nonsense. The Bank of England clearly thinks the size of the money supply has an effect: that’s why it implemented QE. Plus the BoE, as is widely appreciated, has paid careful attention in recent years to the extent to which inflation is cost push. Indeed, it would be a dereliction of duty on the part of the BoE if it ignored the possibility that inflation is partially cost push.

As for the idea that about “willing to accept, if required, the reduction of employment in order to constrain inflation”, it’s widely accepted that there is a trade-off between inflation and unemployment: i.e. that idea is not peculiar to FRB.

Central banks.

Next, Sawyer says “The full reserve proposals are designed to place the stock of money under the direct control of the central bank.”

Not strictly true. Under FR (at least as proposed by Positive Money), the stock of money is controlled by SOME SORT OF committee of independent economists. That COULD BE an existing central bank committee. But it might just as well be an entirely new committee, or some committee in the Treasury.

Of course that’s a minor blemish in Sawyer’s paper, but there seem to rather a large number of blemishes, large and small, in Sawyer’s paper.

Transaction accounts.

Next, Sawyer says, “The purpose of the control of central bank issued money is to influence, if not set, inflation and output. This assumes that the central bank is indeed able to control its issue of money, and that the money issued by the central bank will be placed in transactions accounts…”. Wrong again.

It is extremely unlikely, given a money supply increase, that every single person in the country with a bank account would put all of their share of a money supply increase into either their transaction account or their investment account. Likewise it is extremely unlikely that given an increase in the money supply under the EXISTING SYSTEM, the whole of that increase would be put into current/checking accounts rather than deposit/term accounts. (The latter two types of account, incidentally are very roughly the equivalent of the transaction and investment accounts under PM’s FRB system).

But even if 100% of a particular money supply increase did go into investment accounts, that would not, contrary to Sawyer’s suggestions, destroy the stimulus effect of the extra money. Reason is that more money in investment accounts would tend to cut interest rates which would encourage more investment, and that is stimulatory.

Sunday, 22 November 2015

As regards the insult “crank” (which is repeated several times in the text of the paper), Sawyer and Fontana (S&F) ought to have thought a bit more about who they’re insulting before firing ahead with the insult. Reason is that the advocates of full reserve banking (FRB) are not limited to the ones which S&F concentrate on, namely Positive Money and the New Economics Foundation. (The latter two can certainly be described as “unorthodox”, though “crank” is going too far.)

S&F’s real problem is that other advocates of FRB include Milton Friedman, John Cochrane (currently professor of economics in Chicago), Lawrence Kotlikoff (currently professor of economics in Boston) and the economics Nobel laureate, Merton Miller. Are they all cranks as well? Since S&F don’t mention that the latter four’s acceptance of FRB, I conclude that S&F don’t know about the latter four’s support for FSB, and thus that S&F are not up to speed on this subject.

But obviously I need to substantiate the latter criticism of S&F, so here goes.

S&F’s paper is actually riddled with mistakes. I’ll deal with them in the order in which they appear in the paper. The first two mistakes are not desperately important. They’re under the headings “Mistake No 1” and “The Chicago school” just below, and readers can skip those if they like. But when an author makes numerous minor errors, that is an additional reason for thinking he has a poor grasp of the relevant subject, so I’ve included the minor mistakes.

Incidentally, Sawyer produced another paper on the same subject in the same month as the one dealt with here. That other paper is entitled “The Scourge of Green Monetarism”. Several arguments and points are common to both papers. I’ll deal with the points that are unique to the “scourge” paper in the near future.

Mistake No.1.

The first paragraph of the paper deals with the various phrases used to describe FRB. As the authors put it “A range of terms are used such as 100 per cent reserve banking, positive money, sovereign money as well as full reserve banking…”.

As to “positive money”, that’s the name of an ORGANISATION: called “Positive Money”. I’ve read a huge amount about full reserve banking, and have written a book on the subject, but I’ve never seen the phrase “positive money” used as a synonym for “full reserve banking”.

The Chicago school.

Next, the second half of p1 says the paper will concentrate on the ideas put by Positive Money (PM) and New Economics Foundation authors (PM & Co), but not the ideas of the Chicago school. As S&F put it, “….in this paper we do not further consider those coming from the ‘Chicago proposals’ tradition.”

Well there’s a problem there, which is that PM & Co specifically say, “Our proposal is similar in spirit to and modernizes those put forward by the leading monetary economists of the twentieth century, namely Irving Fisher (1936), Milton Fiedman (1960), and James Tobin (1987).” Now Fisher was very much a member of the Chicago school: at least the differences between Fischer’s ideas and the Chicago school’s were minimal.

The latter quote comes from the submission to Vickers made by PM, the NEF and Richard Werner.

Shadow banks.

On p.2, S&F repeat a criticism of FRB that has been made a dozen times by others, namely that FRB is only concerned with clearing banks or what might be called “regular banks”, and not with shadow banks. As the authors put it, “The FRB proposals only relate to clearing banks, and not to the rest of the financial system.”

That is a simple minded criticism of FRB and the answer is equally simple, namely that any organisation which acts in a bank like manner, whether it calls itself a bank or not, should obey the same regulations. As Adair Turner put it, “If it looks like a bank and quacks like a bank, it has got to be subject to bank-like safeguards.”

If shops selling alcohol were allowed to ignore the law on alcoholic drinks as long as they called themselves “hardware stores” or “wedding dress” shops, the law would look an ass.

To summarise, if bank regulations apply only to organisations that CALL THEMSELVES banks, then those regulations would be a farce, as S&F rightly suggest. The solution is to apply the above “Turner principle”.

Net financial assets.

On p.4 (item (i)) S&F try to challenge a point made by FRB advocates namely that the existing bank system enables private banks to profit from seigniorage.

As part of their argument, S&F distinguish between commercial bank created money and central bank money (i.e. “base money”). They point out that the latter is a net asset as viewed by the private sector, while the former is not. (That incidentally is a point which every MMTer is very well aware of).

S&F conclude from that that “Thus, there is no seigniorage for banks..”

OK, let’s illustrate this with the simplest possible example. Joe Bloggs wants some money so he deposits collateral at a bank, which in turn credits £X to Bloggs’s account. Bloggs then spends it and obtains £X of goods in return. Now ASSUMING that that £X of new money continues to circulate as money, i.e. assuming holders of the money never demand anything back from Bloggs or Bloggs’s bank, then Bloggs and his bank have obtained £X of real goods in exchange for bits of paper, or mere book – keeping entries. Or if you like, Bloggs makes a profit, with the bank taking it’s cut. That’s seigniorage.

In contrast, if the holders of the new money eventually want something back from Bloggs and Bloggs’s bank, and they’re only prepared to hold it if paid interest, then that’s a case of the bank intermediating between lenders (holders of the new money) and a borrower (Bloggs). No seigniorage is involved there.

Intermediation and seigniorage.

Later on the same page and still under item i), S&F say “The profits for banks come from the difference between the rate of interest on loans (with allowance for default) and the costs of deposits including operating costs and any interest payments.”, the suggestion being that the latter is the source of bank profits, not seigniorage.

Well the answer to that is that those two sources of profit are not mutually exclusive: that is, there is nothing to stop banks making a profit from BOTH activities, and that’s in fact what they do (a fact alluded to in the above “Bloggs” illustration.)

Base money doesn’t cause inflation?

Under item ii) on p4, S&F claim that advocates of FRB are wrong to claim that the amount of money printed by the central bank influences inflation. As he puts it “This leads the FRB school into the mistaken belief that inflation can be controlled by the rate of increase of the money supply.”

Well the words “Robert” and “Mugabe” spring to mind. The idea that the amount of money issued by the state has no effect on inflation is straight out of la-la land. Moreover, those CURRENTLY IN CHARGE of western economies (who are not advocates of FRB for the most part) clearly also think the amount of base money in circulation has some sort of inflationary and output increasing effect: that’s why they’ve run large deficits and implemented QE (all of which boils down to much the same as the FRB idea, namely have the state print money and spend it in a recession).

Incidentally, S&F shouldn’t strictly speaking use the phrase FRB in that as they say, they are concerned specifically with PM & Co’s VERSION of FRB, not FRB in a more general sense, i.e. a sense that includes the proposals of the Chicago school, (never mind Milton Friedman or Lawrence Kotlikoff’s versions of FRB). But that’s a minor blemish in S&F’s paper, and it’s a blemish I’m also guilty of in this article. The blemish is certainly minor if, as I claimed above, there is not much difference between the various versions of FRB.

The stock of money.

Next, (p4, item iii)), S&F accuse FRB advocates of claiming that commercial banks alone decide the size of the money supply, i.e. that non-bank entities (e.g. households) have no say in the matter. As he puts it “The amount of money will adjust to that which is required for these transactions purposes. Thus it is not correct to say, as the FRB advocates maintain, that the amount of money is solely determined by the banks…”.

My answer to that is that far as I know advocates of FRB all aware that if households have more transaction money than they need, they’ll tend to dispose of the surplus. I.e. it’s pretty obvious they’ll do a variety of things with that surplus, e.g. use it to repay loans, put it into term accounts, buy stock exchange investments and so on. S&F don’t actually cite any FRB advocates who claim the above obvious nonsense.

Would FRB enhance financial stability?

Page 6 sees the start of a section entitled as above.

S&F say, “The first, and perhaps obvious, point to make is that the FRB proposals would only directly affect a small, if important, part of the financial system. It would impact on the creation of money and hence on banks narrowly defined, but not directly on the role of banks as financial intermediaries between savers and investors..”

My answer to that is “point taken”. However, FRB advocates do not claim that FRB would totally eliminate booms and busts. But, as S&F say, FRB does deal with one factor that contributes to the problem, namely that banks create and lend out money like there’s no tomorrow in a boom.

Ignore private money creation?

Next, and still on the subject of financial stability, S&F make this bizarre claim: “In our discussion here it is not necessary to consider the causes of a single bank failure, often arising from corruption and incompetence, and whether such failure that can be attributed to its role as money creator.”

Well it is precisely the fact of issuing money that makes banks vulnerable and contributes to financial instability!!!!!!

Money is a liability of a bank which is fixed in value (inflation apart). In contrast, the assets of banks (the loans and investments it makes) can turn out to be worth a lot less than book value. Think Spanish and Irish property loans. At that point, the relevant bank is insolvent, or likely to be insolvent.

In contrast, if the liabilities of a bank are VARIABLE in value, e.g. if a bank is funded just by shares, bonds that can be bailed in or something like that, then insolvency is impossible. Plus shares, bonds and the like are not money. Thus (to repeat) it is precisely the fact of issuing money that makes commercial banks vulnerable, as indeed is suggested by Douglas Diamond in the abstract of this paper. As he puts it and in reference to banks’ liquidity or money creation activities, “We show the bank has to have a fragile capital structure, subject to bank runs, in order to perform these functions.”

The solution to that problem as John Cochrane explains is to dispose of the money on the liability side of bank balance sheets, and replace it with what he calls “non runnable” debt (e.g. shares).

Taxpayers to the rescue!!!

S&F than say “As an aside it could be noted that any liquidity issues can be readily dealt with by the central bank as lender of last resort.”

Well of course!! If you’ve got a sugar daddy willing to come to your rescue it doesn’t matter how incompetent you are. And if you want a phenomenally rich sugar daddy, what better than a central bank with the freedom to print limitless amounts of money and backed by taxpayers? Problem is that that constitutes a subsidy of banks, and subsidies do not make economic sense.

Incidentally it could be argued that central bank / government assistance for commercial banks CAN BE implemented on a commercial basis, in which case there would be no subsidy involved. Indeed, the FDIC is self-funding. But the FDIC only caters for small banks. When it comes to large banks or a series of large banks, state assistance is the only option that that assistance JUST ISN'T offered on a commercial basis: politicians would far rather quickly paper over the cracks in the bank system (the source of much of the money for politicians’ election expenses) than have banks face brute commercial reality and fail.

The fourth section of Sawyer’s paper is entitled as just above. He argues basically that banks would circumvent the rules of FRB. There are numerous answers to that point, as follows (and numbered).

1. FRB does not aim to totally eliminate all forms of privately created money. For example most FRB advocates (in my experience) favour local currencies like the Bristol pound.

2. There is a MAJOR PROBLEM facing any bank or similar entity trying to circumvent the rules, which problem S&F don’t mention. It’s as follows.

The ease with which money can be issued is related to the size of the entity that issues it. To illustrate, plastic cards issued by or cheques drawn on well known banks are widely accepted. In contrast, IOUs issued by some medium size City of London hedge fund are completely useless for 99% of transactions outside the City of London, e.g. shopping at supermarkets.

Plus, while it may be hard to keep an eye on what every small shadow bank or hedge fund is doing, it’s relatively easy for the authorities to see what the largest banks (regular and shadow) are doing. Thus keeping tabs on the vast bulk of the potential sources of privately issued money shouldn’t be difficult.

3. S&F assume that FRB advocates claim that money in deposit or term accounts where access takes 7 or 14 days is not counted as money. Well if S&F are arguing that money available in 7 days is effectively the same as instant access, I quite agree. But I’ve no idea where S&F get that 7-14 days from. Two or three months is the time normally cited I my experience. Plus that two or three months is a common dividing line between money and non money used by several countries around the world when measuring their money supply.

4. The rules of FRB are simplicity itself compared to Dodd-Frank. And if you want an example of useless bank regulations, look no further than Dodd-Frank. As Richard Fisher, former head of the Dallas Fed, put it, “We conclude that Dodd-Frank has not done enough to corral “too big to fail banks” and that, on balance, the act has made things worse, not better.”

5. If S&F are trying to claim banks haven’t circumvented EXISTING regulations to any great extent, than that’s just a joke. In the US, banks have had to pay a good $100bn in fines for various crimes. Thus if banks DO CIRCUMVENT the rules to some extent under FRB, the extent of circumvention could hardly be worse than under the existing system.

Budget deficits and money creation.

S&F’s fifth section is entitled as just above, and they make the bizarre claim that “The full reserve banking proposals in contrast constrain government expenditure through setting down a rule as to how much money can be created.”

As PM & Co make clear, under FRB government is free to raise tax by any amount it likes and spend the relevant money. Indeed the latter “tax and spend” decision is quite clearly a POLITICAL decision and it would be wholly wrong for a central bank (or PM’s “Money Creation Committee”) to interfere or in any way influence that decision.

Indeed, that point is so obvious that (to repeat) it is bizarre that S&F think the likes of Positive Money or Richard Werner would be unaware of it.

S&F then repeat the above ridiculous point several times, e.g. a few sentences later they say “…if the growth of the money supply was on track to exceed the target, then the central bank would be forced to deny financing for government expenditure.”

The answer is (to repeat) that under the PM/Werner/NEF system, governments are free, as they are now, to increase “government expenditure” by any amount they like and by collecting extra tax.

What if there’s too much stimulus?

The first half of S&F’s p.14 claims that under FRB whoever decides on how much new money to create (i.e. how much stimulus there should be) might get it wrong. In particular, they might create too much new money in which case the private sector would “bid up prices”, i.e. inflation would ensue.

Well of course that’s a possibility! But are S&F trying to suggest that the authorities under the EXISTING SYSTEM always gauge the amount of stimulus correctly? Any idea that the amount of stimulus after the 2007/8 crisis was adequate given the seven years of excess unemployment that came after that crisis is just a joke. And remember that that crisis was largely the result of a chronic bank system.

If FRB is going to improve on the existing system, frankly it doesn’t have a very high bar to surmount: it could hardly be worse than the existing system.

Fiscal policy is “subordinate”?

In the second half of p.14, S&F claim that under FRB fiscal policy become “subordinate” to monetary policy, and that that is highly undesirable. In the authors’ words:

“The second point is the intimate link between the budget deficit and the change in the stock of money. It then becomes important as to whether the budget deficit determines the change in stock of money or whether the change in the stock of money determines the budget deficit. Under the FRB proposals it is clearly the latter. The central bank then imposes a target growth for the stock of money for the coming period (say year), and that in turn imposes a target for the budget deficit. Thus fiscal policy becomes completely subordinated to monetary policy.”

The reality is that under PM &Co’s FRB system, monetary and fiscal policy are joined at the hip, and there is no clear reason for saying that one is subordinate to the other. That is, if one implements stimulus by creating new base money and spending it, there is an obvious monetary element there: the money supply rises. But there is also an obvious fiscal element, namely that public spending rises (and/or taxes are cut).

Frankly I couldn’t care less which of those two effects is dominant, or whether the effect of the two is the same. And nor (far as I know) does PM. The important point is that as long as one of them works, then stimulus is effected, and unemployment falls.

Automatic stabilisers.

On p.15 S&F claim that FRB would prevent the automatic stabilisers from working. Well that depends on the rules and conventions governing the money creation process.

Clearly if the rule was that the authorities shall decide how much new money shall be created and spent over the next year REGARDLESS of the arrival of a recession in that year, then FRB would indeed thwart the automatic stabilisers.

However, a more sensible rule – and it doesn’t take a genius to work this out – is that the authorities decide how much new money to create and spend on all items OTHER THAN automatic stabiliser items (like unemployment benefit). I.e. government would have freedom to spend more on unemployment benefit if the number of unemployed rose.

An alternative would be for the central bank or Money Creation Committee to keep an eye on the number of unemployed and adjust the amount of new money to create accordingly. That’s what might be called a “semi-automatic” system.

To summarise, S&F’s criticism relating to automatic stabilisers is one that is very easily dealt with.

Debt free money.

The sixth and final section of S&F’s paper entitled “Debt free money”, tries to cast doubt on the claim by Positive Money that base money is “debt free”. Unfortunately S&F don’t add anything of any interest to the debate on this topic.

It is widely recognised, and not just by FRB advocates, that money created by commercial banks is not debt free in the sense that for every dollar created, there is a dollar of debt. In contrast, base money is an asset as viewed by the private sector. Thus PM are right to make that point. MMTers (perhaps another lot of “cranks” in the eyes of S&F), often make the same point.

S&F also make the following not too clever point. “Hence the creation of money raises the net financial assets, and carries the implication that the more money is ‘printed’ the better off (wealthier) people will feel. Yet there is no increase in the capacity of the economy to produce.”

What – so printing bits of paper with £10 stamped on them doesn’t automatically cause factories complete with associated machinery to appear from nowhere? Did Positive Money ever say that the latter magic apparition would actually occur once the printing presses start rolling? Not far as I know.

The basic purpose of creating new money and spending it (and/or cutting taxes) is to raise demand, and that in turn (where there is inadequate capital investment) will cause office blocks to be erected, factories to be built and so on.

As I said, there is nothing of substance in this sixth and final section.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

.

Bits and bobs.

.

As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

.

MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A